Capital market liberalization and systemic risk of non-financial firms: Evidence from Chinese Stock Connect scheme

This paper examines the causal effect of capital market liberalization on the systemic risk of non-financial firms (NFFs), a topic that has received little attention in the literature. We exploit the launch of China's Stock Connect scheme as a quasi-natural experiment to identify the causal effect and find that capital market liberalization significantly raises the systemic risk of NFFs in China, especially for those with more concentrated supply chains and more reliance on trade credit. We explain this result by three main channels: increased market concentration, interfirm connectedness, and exposure to financial shocks. We also provide evidence that the inquiry letter and the Stock Connect Northbound Investor ID Model system, two regulatory measures implemented during the liberalization of China's capital market, mitigate the adverse effect of liberalization on the systemic risk of NFFs. Our findings offer new insight into the nexus between financial liberalization and instability and highlight the importance of strengthening regulations of capital markets to enhance the benefits of liberalization and reduce its risks for economic and financial stability.